The use of underlying profit as an indicator of corporate performance risks misleading investors, according to a recent study conducted by Deloitte. The firm surveyed the 2010 annual reports of 100 publicly listed and other large New Zealand companies, finding that in 92% of the filings, the highlighted underlying profit improved the statutory profit result by either increasing the profit figure, turning a loss into a profit, or reducing a loss.

The survey also found 39% of the companies that used underlying profit emphasised the alternative measure in the annual report, with little or no discussion on statutory profit.

Further, the annual reports of 87 out of the sample of 100 companies, provided 214 alternative earnings or profit measures of which 25% were not clearly reconciled to statutory profit, leaving investors without a clear reference point for assessing performance.

Underlying profit is an important development in reporting corporate performance as it provides useful information on the ‘normalised’ profit of the company, excluding significant one-off gains/losses and expenses and their associated tax effects. 

However, it should not receive greater priority than any commentary on statutory results and like any emerging approach, it is critical that it is transparent and consistently applied year-to-year across the company and across industry sectors.

When assessing executive remuneration, investors should be on the lookout for instances where the management team is reporting underlying profit to the market but is measuring performance in its incentive schemes by some other metric. Investors should also consider the degree of transparency of underlying profit disclosures, the trend across reporting periods and whether the adjustments are comparable between reporting periods.

Last Updated: 29 July 2011